Publication "Evaluation of the Fulfilment of the CNB's Inflation Targets 1998-2007"

ISBN 978-80-87225-11-0

Original versions of the included papers were written by an extensive team of authors for the meeting of the Bank Board with experts. The aim of this meeting was to assess the ten-year experience with inflation targeting and to contribute to its improvements in the forthcoming years. Following the above mentioned internal discussion, the papers were redrafted and then reviewed by three renowned experts in the Czech monetary policy. This publication represents part of the Czech National Bank's efforts to achieve the maximum transparency of the monetary policy.

Contents

Kateřina ŠmídkováAbstract: The introductory paper defines three stages of Czech inflation targeting and defines possible factors behind inflation deviations from inflation targets in 1998-2007. The paper also summarises the findings of analyses by CNB experts, which are presented in further chapters of the volume. According to these findings, deviations from targets cannot be explained by one factor alone. During various stages of inflation targeting, individual factors were of varying importance. Anti-inflationary shocks were the most frequent reason for deviations. Another significant reason – especially in the initial and advanced targeting stages – was the prognostic system. The decision making process for interest rates only contributed to undershot targets in the initial stage, during which it was necessary to build up the credibility of the new monetary policy strategy.JEL Codes: E37, E52, E58Keywords: macroeconomics, monetary policy, inflation targeting

Juraj Antal, Michal Hlaváček, Tomáš HolubAbstract: This paper investigates basic characteristics of inflation targeting in the Czech Republic. The first part of the paper starts by briefly indicating some general macroeconomic conditions of inflation targeting in the Czech Republic, including the identification of the main shocks, which affected them. In addition, the extent of non-fulfilment of the inflation target in the Czech Republic is compared to the experience of several inflation targeting foreign countries. A comparison of the inflation target fulfilment in various phases of inflation targeting reveals a changing success rate in the fulfilment of the target in time. While deviations of inflation from the targets were very high in international comparison in the early phase of inflation targeting, the Czech National Bank has lately come closer to the characteristics of relatively more successful inflation targeters.JEL Codes: E37, E52, E58Keywords: macroeconomics, monetary policy, inflation targeting

Michal SkořepaAbstract: In the period 1998-2007, inflation very often deviated from inflation targets of the Czech National Bank, most of these deviations being in the direction of undershooting the targeted level. In this paper, a purely statistical, model-independent procedure is used to search for an answer to the question of whether this clear asymmetry in inflation target fulfillment can be explained more by an asymmetry in outside shock or an asymmetry of the Czech National Bank’s monetary policy. Our results indicate that the latter explanation is statistically more persuading. For the period since 2002, moreover, it looks like the decisions of the Czech National Bank’s Bank Board more or less sticked to the recommendations implicit in materials supplied by the Bank’s forecasting team; the bias in this second period, at least, can therefore be ascribed to the Bank‘s forecasting apparatus rather than preferences of the Bank Board as revealed in its monetary policy decisions.JEL Codes: C22, E31, E52Keywords: inflation targeting, inflation persistence, autoregression models

Tomáš HolubAbstract: This paper provides an empirical analysis of the causes of deviations of inflation from the CNB targets. In the short term, shocks relating to prices of agricultural producers represent the most important factor. In the medium-term horizon, foreign exchange shocks form the most important factor. At the same time, it could not be proved that monetary policy would create any major shocks contributing to the non-fulfilment of inflation targets, although its certain role cannot be excluded either.JEL Codes: E31, E52, E58Keywords: inflation targeting, VAR model, exchange rate

Juraj Antal, Michal Hlaváček, Roman HorváthAbstract: This paper is primarily concerned with assessing the bias of the CNB's predictions in relation to undershooting of the inflation target. We conclude, that the inflation prediction error has decreased over time. We further point out that the GDP growth respectively interest rates were above respectively below the forecast most of the time, even in the situation of systematic undershooting of the target. Thus, undershooting then cannot be explained with the help of standard demand mechanisms and positive supply impulses were admittedly underestimated in the past. According to our findings, about half of the apparent amount of target undershooting in 2003 was to be attributed to errors in exogenous factor (foreign interest rates, GDP and inflation) predictions. As follows from the distribution of inflation prediction errors across separate price segments, overpredictions of inflation during a prevailing portion of the period under review were to be attributed to mistakes in prediction of food prices and core CPI ex food, while prediction errors in energy prices mostly rather helped to approach the target. Prediction errors in regulated prices were acting in both directions.JEL Codes: E37, E52, E58Keywords: macroeconomics, monetary policy, inflation targeting, forecasting

Jan Babecký and Jiří PodpieraAbstract: The results of our empirical analysis rather serve in support of a hypothesis that inflation target undershooting occurs because the economy has been exposed to a series of shocks restraining inflation (the hypothesis of long series of asymmetric shocks) and in part also because the prognostic apparatus has been biased (the hypothesis of skewed sight) as compared to the other institutions. In view of the recent literature dealing with the accuracy of forecasts, which shows that using more models leads to more reliable forecasts (Fildes and Stekler, 2002), it can be argued that the development and application of alternative prediction models would improve forecast accuracy.JEL Codes: E31, E37, E58Keywords: Evaluation of inflation forecasts, monetary policy, Czech Republic

Zuzana Antoničová, Karel Musil, Luboš Růžička, Jan VlčekAbstract: The paper is aimed at the evaluation of quality and the success-rate of the past Czech National Bank’s forecasts created from 2004 until mid-2006. It strives to identify the factors which have caused deviations from reality in the past forecasts and could contribute to non-fulfilment of the announced inflation target. There are three groups of factors, which have most often contributed to the overvaluation of the historical forecasts: ex post incorrect setting up of the equilibrium trajectories, non-fulfilment of some exogenous presumptions together with an influence of unexpected shocks, and inaccurate capture of some behavioural relationships within the model apparatus. According to a comparison of historical and adjusted forecasts against reality, forecasts produced during the reviewed period of time are diverted on average towards higher inflation, lower real growth, and more depreciated nominal exchange rate. Consistently, the implied trajectory of the interest rate is higher than reality. Nevertheless, the deviations of the basic macro-economic variables gradually decrease with the course of time.JEL Codes: E17, E37, E58, C60Keywords: Monetary policy, inflation target fulfilment, macroeconomic forecast, forecast deviation, Czech National Bank

Jarek Hurník, Ondra Kameník, Jan VlčekAbstract: Using a dynamic general equilibrium model calibrated for the Czech Republic and the method of Kalman filtration we first estimate impact of structural shocks on the observed realization of interest rate and inflation, while the main focus is put on the estimation of monetary policy shocks. These occur whenever monetary policy is not set in accordance to the observed state of the economy and inflation target. Our results suggest that monetary policy was more restrictive than implied by the observed state of the economy and inflation target in three periods: from the second quarter of 1998 till the first quarter of 1999, from the third quarter of 2001 till the second quarter of 2003 and finally from the third quarter of 2004 till the end of 2005. In contrary, in period from the third quarter of 2003 till the second quarter of 2004 we identify looser monetary policy. Consequently and based on the assumption that monetary policy does not make mistakes, but focuses on a different inflation target than the officially announced one, we estimate an implicit trajectory of the inflation target. Inflation target that well fits the observed behaviour of the central bank is inflation targets fluctuating between 2 and 3 % since the year 2002.JEL Codes: E31, E43, E52Keywords: monetary policy shock, dynamic general equilibrium model, Kalman filtration

Roman HorváthAbstract: This paper analyses a hypothesis, whether an asymmetric monetary policy could contribute to the undershooting of the inflation targets of the Czech National Bank in the years 1998-2007. To this goal, a non-linear Taylor Rule has been estimated. The results indicate that – upon the introduction of inflation targeting – the Czech National Bank responded more aggressively to forecasts of inflation heading above the target. That asymmetric monetary policy, however, disappears if we perform estimates of the monetary policy rule exclusively on the basis of more contemporary data (approx. 2002-2007). Therefore, it could be deemed that symmetric handling of the inflation targets prevailed in the past several years.JEL Codes: E31, E43, E52, E58Keywords: Monetary policy rule, inflation target, Czech National Bank

Roman HorváthAbstract: This article addresses the role of the inflation target with respect to inflation expectations developments using the vector error correction (VECM) and block restriction vector autoregression (VAR) models, based on the monthly data of 1999-2007. The econometric analysis performed has not identified any grounds in support of the “hypercredible” inflation target hypothesis, under which a 1 pp decrease would be accompanied by a decrease of inflation expectations by more than 1 pp. The results however suggest that the inflation target is a major determinant of inflation expectations, its importance for creating the inflation expectations surpassing even that of the current inflation development. Another conclusion is that inflation expectations decrease significantly in response to a stricter monetary policy and to the lower inflation target. On the overall, the results imply that the monetary policy has anchored the inflation expectations.JEL Codes: E31, E52, E58Keywords: Inflation expectations, inflation target, Czech National Bank